Chapter Outlines - Chapter 11 Fi by fjhuangjun


									                  Ch. 1:         THE NATURE OF FRAUD
   I. What is fraud – (Slides 5 & 6) An intentional material misstatement which is
      relied on by the victim and which results in damages to the victim. Often
      described as consisting of seven elements (page 7). The Key to occupational fraud
      is that the activity- Slide 7
      A.       Is clandestine (done secretly)
      B.       Violates the employee’s fiduciary duties to the organization
      C.       Is committed for the purpose of direct or indirect financial benefit to the
      D.       Costs the employing organization asset, revenues, or reserves.

II.    Cost of Fraud- Each $1 of fraud reduces net income by $1-Slide 4. Thus, if net
       income to sales is equal to 10%, a $100,000 theft means that the company would
       have to generate $1 million of sales to recover the effect of the fraud on net
       A.     A typical organization loses 5% of its annual revenue to fraud (2006
              Report to the Nation).
       B.     The median dollar loss per 2006 Report was $159,000.

III.   Types of fraud – Slide 8
       A.     Employee embezzlement - employees deceive their employers by taking company assets.
              1.      Direct fraud - Company assets go directly into the perpetrator's pockets without the
                      involvement of third parties.
              2.      Indirect fraud- Employees take bribes or kickbacks from vendors, customers or
                      others outside the company to allow for lower sales prices, higher purchase prices,
                      nondelivery of goods or the delivery of inferior goods. Payment to employees is
                      usually made by organizations that deal with the perpetrator's employer, not by the
                      employer itself.
       B.     Management fraud - involves top management's deceptive manipulation of
              financial statements.
       C.     Investment scams - usually worthless investments are sold to unsuspecting
              investors (includes telemarketing fraud).
       D.     Vendor Fraud - usually results in either an overcharge for purchased
              goods, the shipment of inferior goods, or the nonshipment of goods even
              though payment was made.
       E.     Customer Fraud- customers either do not pay for goods purchased, or they
              get something for nothing, or they deceive organizations into giving them
              something they should not have.
 IV. Prosecution for Fraud – Slide 9
     A.     Criminal Law- Prosecuted either federally or by a state for violating a
            statute that prohibits activity.
            1.       Results in jail sentences and/or fines.
            2.       Perpetrators must be proven guilty "beyond a reasonable doubt."
            3.       Juries (must consist of 12 jurors) must rule unanimously on guilt
                     for conviction.

      B.      Civil Law - deals with violations of private rights (rights and duties
              between individuals).
              1,     Purpose is to compensate for harm done to another individual.
              2.     Verdict of the jury need not be unanimous. Jury need not consist of
                     12 individuals (may have as few as 6).
              3.     Plaintiff must only prove their case by "preponderance of the
                     evidence" (slightly more evidence for plaintiff).

V.    Fraud Related Careers – Slide 10
                 Ch. 2:         Why People Commit Fraud
I.    Who Commits Fraud - Characteristics of incarcerated fraud perpetrators,
      compared to property offenders.
      A.    Less likely to be caught, turned in, arrested, convicted and incarcerated.
      B.    Less likely to serve long sentences
      C.    Only 2% of property offenders are female. The 2006 Report indicated that
            39% of the fraud cases involved females (61% males) and that the median
            loss for men was $250,000 and for women, $102,000.
      D.    Fraud perpetrators are better educated, more religious, less likely to have
            criminal records, less likely to have abused alcohol, and considered less
            likely to have used drugs.

II.   Why People commit fraud - The Fraud Triangle – Slide 4
      A.    Perceived pressure – Slides 5-8
            1.      Financial pressures - Greed, living beyond one's means, high bills
                    or personal debt, poor credit, personal financial losses, and
                    unexpected financial needs.
            2.      Vices - addictions such as gambling, drugs, and alcohol - and
                    expensive extramarital relationships.
            3.      Work related pressures - not enough recognition for job
                    performance, dissatisfaction with the job, fear of losing one's job,
                    being overlooked for a promotion, and feeling underpaid motivate
                     many frauds.
            4.      Other pressures - such as a spouse who insists on an improved
                    lifestyle or a desire to beat the system.
      B.    Opportunity – Slide 9
            1.      Lack of controls or circumvention of controls.
            2.      Inability to judge quality of performance.
            3.      Failure to discipline fraud perpetrators.
            4.      Lack of access to information.
            5.      Ignorance, apathy, and incapacity
            6.      Lack of an audit trail.
      C.    Rationalization or lack of integrity. - Almost every study of honesty
            reveals that levels of honesty are decreasing.
      D.    The fraud scale - shows the relationship among the three fraud elements.
            1.      The greater the opportunity or the greater the pressure, the less
                    rationalization it takes to motivate someone to commit fraud. Also,
                    the more dishonest a person, the less opportunity and/or pressure it
                    takes to motivate fraud.
            2.      Most people who try to prevent fraud usually work on opportunity.
                    They believe that opportunities can be eliminated by having good
                    internal controls.
       III.      Internal Control Structure – See Table 2.1
                 A.      Control environment
                 B.      Accounting system
                 C.      Control Activities

                          Ch. 3: Fighting Fraud: An Overview

I.            Fraud Prevention
              A.     Create and maintain a culture of honesty and integrity
                     1.     Insist that top management model appropriate behavior.
                     2.     Hire the right kind of employees.
                     3.     Communicate expectations throughout the organization.
                     4.     Create a positive work environment. For a list of factors associated
                            with high levels of fraud and detract from positive work
                            environment see page 78-79. See slides 3-4.
              B.     Assessing and mitigating the risk of fraud.
                     1.     A process must be in place which defines areas of greatest risk and
                            evaluates and tests controls that minimize those risks.
                     2.     Risks that are inherent in the environment can be addressed with
                            an appropriate system of internal control.
                     3.     Research shows that employees and managers -not auditors- detect
                            most frauds. Thus, they must be taught how to watch for and
                            recognize fraud.

II.           Fraud Detection - Three primary ways to detect fraud
              A.     By chance - in the past, most frauds were detected by accident.
              B.     By proactively searching for and encouraging early recognition of
                     1.     Hotlines- SOX-Sec. 307 requires public companies to have a
                            whistle-blower system in place. Sec. 806 prohibits retaliation
                            against any employee reporting questionable activities using the
                            whistle-blower system.
                     2.     Analyze and mine databases to search for red flags.
              C.     By proactively eliminating fraud opportunities
                     1.     Identifying sources of fraud and measuring risks
                     2.     Implementing preventative and detective controls
                     3.     Creating widespread monitoring by employees
                     4.     Having independent checks, including and effective audit function

III.          Fraud Investigation
              A.     Must be based on "predication of fraud." Predication refers to
                     circumstance that would lead a reasonable, prudent professional to
                     believe a fraud has occurred, is occurring, or will occur.
              B.     Investigations must have management's approval.
      C.     Four types of evidence, p. 84 -Slide 7
             1.      Testimonial evidence
             2.      Documentary evidence
             3.      Physical evidence
             4.      Personal observation
      D.     Components of the Fraud Element Triangle that may be used to classify
             investigative approaches:
             1.      Theft act
             2.      Concealment
             3.      Conversion
      E.     Components of the Fraud Motivational Triangle:
             1.      Pressure
             2.      Opportunity
             3.      Rationalization
      F.     Conducting a Fraud Investigation – See 7 steps for conducting a fraud
             investigation, pp. 85-86.

IV.   Legal Action
      A.     No legal action - taken in more than half of all fraud cases.
             1.     Pursuing legal action is expensive, time-consuming, sometimes
                    embarrassing, and often considered an unproductive use of time.
             2.     If no legal action is taken, word spreads that "nothing serious will
                    happen if you steal from the company."
      B.     Civil Action - purpose is to recover money or other assets from
             perpetrators. Slide 9
             1.     Are rare in cases of employee fraud.
             2.     Are much more common when frauds involve other organizations.
      C.     Criminal Action- Slide 10
             1.     Can only be brought by law enforcement or statutory agencies.
             2.     Involve fines, prison terms or both.
             3.     Much more difficult to get a criminal conviction than it is to get a
                    judgment in a civil case. Why?
                           Ch 4: Preventing Fraud
I.    Create a culture of honest, openness &assistance
      A.     Hire honest people and provide fraud awareness training
             1.      Surveys show 30% of people are always dishonest, 40%
                     situationally dishonest, and 30 always honest.
             2.      Avoid negligent hiring claims by resume verification and
                     certification. Most claims result from violence or abuse of the
             3.      Educate employees as to what is acceptable and unacceptable, how
                     they are hurt when some is dishonest, and what actions they should
                     take if they see someone being honest.
      B.     Create a positive work environment – 3 elements –Slide 3
             1.      Create expectations about honest through a good corporate code of
                     conduct. SOX- Sec. 406 requires public companies to have a code
                     of ethics for management and its board of directors. SEC requires
                     public companies to create and distribute a code of conduct to all
             2.      Have open-door policies
             3.      Have positive personnel and operating procedures. See pp. 107-
                     108 for list of personnel and operating conditions and procedures
                     that contribute to a high-fraud environment.

II.   Eliminate opportunities for fraud –Five ways- Slide 4
      A.     Have good internal controls
      B.     Discourage collusion between employees and customers or vendors – 71%
             of frauds are committed by individuals alone. 29% involve collusion
             which often involves large amounts of losses. Collusion is slow to
             develop. Seems to involve corruption, bribes, kickbacks and fraudulent
             financial statements.
      C.     Monitor employees-pay attention to employees lifestyles
      D.     Create expectation of punishment-Real punishment involves telling family
             members and friends about dishonest behavior.
      E.     Conduct proactive auditing-creates an awareness among employees that
             their actions are subject to review at any time. Good fraud auditing
             involves: - Slide 7
             1.      Identifying risk exposures
             2.      Identifying fraud symptoms of each exposure
              3.     Building audit program to proactively look for symptoms and
              4.     Examine fraud symptoms identified

III.   Whistle-blower Systems
       A.     Effective systems must have: Slide 6
              1.      Anonymity
              2.      Independence
              3.      Accessibility
              4.      Follow-up
       B.     Why do whistle-blowing systems fail?
              1.      Lack of anonymity
              2.      Poor example set by management
              3.      Unclear policies
              4.      Lack of awareness

IV.    Organizations and fraud-the current model – Slide 9
       A.     Fraud incident – Firm shifts to a crisis mode
       B.     Investigation- involves interviewing and document examination. May not
              lead to resolution. Can take extensive time and be costly.
       C.     Action- Options?
       D.     Resolution – replace employee, implement new controls.

V.     Sound organizations with minimal fraud – Slide 10
       A.    Tone at the top
       B.    Education & training
       C.    Integrity risk and controls
       D.    Reporting and monitoring
       E.    Proactive detection
       F.    Investigate and follow-up
               Ch 5: Recognizing the Symptoms of Fraud

I.     Symptoms of Fraud – Slide 4
       A.    Accounting anomalies
       B.    Internal control weaknesses
       C.    Analytical anomalies
       D.    Extravagant lifestyle
       E.    Unusual behavior
       F.    Tips and complaints

II.    Accounting anomalies – Slide 5
       A.    Irregularities in source documents
       B.    Faulty journal entries
       C.    Inaccuracies in ledgers

III.   Internal control weaknesses- Slide 6
       A.      Lack of segregation of duties
       B.      Lack of physical safeguards
       C.      Lack of independent checks
       D.      Lack of proper authorization
       E.      Lack of proper documents and records
       F.      Overriding of existing controls – Many studies show this to be the element
               most common in frauds
       G.      Inadequate accounting system

VI.    Analytical fraud symptoms
       A.     Procedures or relationships that are unusual or too unrealistic to be
       B.     Common examples – Slide 7
       C.     Recognizing these symptoms is an excellent method of detecting fraud
       D.     Sometimes analytical relationships stay the same even when fraud is being
              perpetrated – WorldCom.

V.     Extravagant lifestyles – Slide 8
       A.     Few perpetrators save what they steal
       B.     Lifestyle changes are often the easiest to detect
       C.     Helpful in detecting fraud against organizations but not as helpful in
              detecting fraud on behalf of a corporation (management fraud).
VI.    Unusual behaviors – Slide 9
       A.    Chain that leads to unusual behavior
               1.     Guilt
               2.     Fear
               3.     Stress
               4.     Behavior changes
       B.    Examples of behavior changes
       C.    No particular behavior signals fraud; rather, changes in behavior are
       D.    Individuals who commit frauds or crimes and do not feel stress are called
             sociopaths or psychopaths. They have no conscience.

VII.   Tips and complaints – Slide 10
       A.     Many tips and complaints turn out to be unjustified or do not indicate that
              fraud has occurred.
       B.     Elements of Fraud – Theft, conversion and concealment. Who in the
              organization is in the best position to recognize fraud in each of these
       C.     Why do employees who have knowledge or suspect fraud do not come
              forward with this information? – Slide 21
                    Ch. 6: Data-Driven Fraud Detection
I.     Fraud detection vs. investigation
       A.     Fraud detection – identifying symptoms that indicate fraud has been or is
              being committed.
       B      Fraud investigation – after symptoms have been identified, fraud
              investigation determines who committed the fraud, the scheme used, when
              it was committed, what motivated it, and how much money or other assets
              were taken.

II.    Fraud vs. Anomalies – Slide 4
       A.     Anomalies – Caused by failures in the system, procedures, and policies
                1.      Are not intentional
                2.      Found throughout a data set
                3.      Sampling is very useful in finding anomalies
       B.     Fraud- Intentional subverting of controls and creation of false documents
              1.      Evidence of fraud found in very few transactions
              2.      Fraudulent symptoms found in limited areas of data set
              3.      Sampling usually a poor analysis in detecting fraud. Must look at
                      complete population data. Computers very helpful.
III.   Data Driven Approach – a proactive approach to detecting fraud – Slide 5
       A.     Understand the business
       B.     Identify possible frauds that could exist
       C.     Catalog possible fraud symptoms
       D.     Types of fraud symptoms
       E.     Use technology to gather data about symptoms
       F.     Analyze results
       G.     Investigate symptoms

IV.    Data Analysis
       A.    Software - Slide 6
       B.    Access – Slide 7
       C.    Techniques
             1.      Digital analysis
                     a. The art of analyzing the digits that make up numbers
                     b. Benford’s Law – A rule of data sets. First digit of a random data
                        set will begin with 1 more often than with 2, 2 more often than
                        with 3, etc. Applies only to numbers that have similar items.
                        Does not apply to assigned numbers (personal ID numbers) or
                        lists where numbers have built in minimums or maximums or
                        have preassigned patterns. Least expensive method to use.
                        However, this method only broadly identifies the possible
                        existence of fraud. Not precise
            2.      Fuzzy Matching
            3.      Time Trend Analysis

V.   Effect of fraud on financial statements
     A.      Small frauds- unlikely to effect financial statements. Generally detected by
             examining source documents.
     B.      Large frauds- Effect financial statements (management fraud). Generally
             detected during analysis of unexplained changes in financial statements
             1.      Balance sheet and income statements must be converted to change
                     statements to detect fraud. The statement of cash flow is a change
             2.      Detecting fraud through ratios is much easier than using
                     comparison of numbers. We have industry ratios as benchmarks.
                     Significant changes in ratios are easier to identify.
     C.      Approaches to Financial Statement Analysis – Slide 10
             1.      Compare account balances from one period to the next
             2.      Calculating key ratios and comparing them
             3.      Performing horizontal and vertical analysis
                     a..     Vertical Analysis- An analysis of relationships within a
                             particular financial statement by comparing one item with a
                             base item. Example, if sales is used as the base account, it
                             is assigned a value of 100 and all other accounts are stated
                             relative to sales. Financial statement numbers are converted
                             to percentages.
                     b.      Horizontal – A comparison of the same line items (or
                             accounts) across time periods. Example, the current year
                             balance of sales could be compared to other balances for
                             sales for each of the five previous years. Often considered a
                             side by side comparison of data. Horizontal analysis is the
                             most direct method of focusing on changes.
                    Chapter 7: Investigating Theft Acts
I.     Two approaches to fraud investigation
       A.    The evidence square approach
       B.    The fraud triangle plus inquiry approach – Slide 4
             1.     Theft investigative methods
             2.     Conversion investigative methods
             3.     Inquiry investigative methods
             4.     Concealment investigative methods

II.    Must decide whether to investigate
       A.    Perceived strength of the predication
       B.    Perceived cost of the investigation
       C.    Exposure or amount that could have been taken
       D.    Signal that investigation or noninvestigation will send to others in
       E.    Risks of investigation or not investigation
       F.    Nature of the possible fraud

III.   Theft act investigations
       A.     General – use techniques that will not arouse suspicion or incriminate
                              innocent people. Work inward toward the suspect
       B.     Vulnerability chart – shows what was taken, who had opportunity, how
              were assets moved, how was theft concealed, how are assets converted,
              red flag symptoms, possible motives, and key internal controls involved
       C.     Methods – Slide 5
              1. Surveillance and covert operations
              2. Invigilation
              3. Seizing and searching computers
              4. Physical evidence

IV.    Surveillance and covert operations
       A.     Rely on the senses – hearing and seeing
       B.     Watching and recording the physical facts, acts, and movements involved
              in the fraud act
       C.     Are legal as long as they do not invade a person’s reasonable expectation
              of privacy under the Fourth Amendment.
       D.     Undercover operations are legal provided they are not used as fishing
              expeditions. Should be used only under certain conditions
       E.     Three types of surveillance – Slide 6
              1.       stationary or fixed point
              2.       moving or tailing
              3.       electronic
V.      Invigilation-Slide 7
          A.      Involves close supervision of suspects during an examination period.
                  Detailed records are maintained before, during and after strict controls to
                  see if fraud is occurring. Useful in high risk – low control areas
          B.      Should have management approval and can be expensive
          C.      A minimum of 14 days should be invigilation period

VI.     Seizing and searching computers
         A.      Data may be stored on a corporate database, personal computer, or e-
                 mail server
         B.      Consult with attorneys to ensure you have legal right to seize hardware.
         C.      Seize in the presence of at least one neutral witness
         D.      Cut power by unplugging it directly or removing its battery.
         E.      Calculate a checksum number and clone it to another drive. Must show
                 court that you have not modified the disk since seizure.

VII.    Physical evidence – Slide 8-Involves analyzing items such as inventory, assets,
        broken locks; substances such as grease and fluids; impressions such as cutting
        marks, tire tracks, and fingerprints or searching computers.

VIII.   Process of Gathering Electronic Evidence – Slide 9
          A.     Secure the device – be sure you have legal right to seize, take pictures of
                 site and have neutral witness on the scene.
          B.     Clone the Device and calculate a CRC Checksum – Use software that
                 copies bit by bit. Two checksum methods are MD5 and SHA-1
          C.     Search the device manually – computer logs, web favorites, documents
                 folder, trash can, UDB keys, chat logs and e-mail caches.
          D.     Search the device using automated procedures – Keyword searches, etc.
                 Chapter 8: Investigating Concealment

I.   Concealment investigative methods
     A.    Involves ways to gather physical documents or computer records that have
           been manipulated or altered. These documents include purchase invoices,
           sales invoices, credit memos, deposit slips, checks, receiving reports, bills
           of lading, leases, titles, sales receipts, money orders, cashier’s checks,
           insurance policies, etc.
     B.    Chain of custody – must be maintained for documents to be accepted in
           court. Detailed records must show what happened to documents from time
           of receipt to date it is presented in court. Must prove it has not been altered
           or tampered with. Slide 4
     C.    Marking the evidence- so it can be identified later. Note date received and
           store in transparent envelope. Use copy for investigation purposes and
           original for court. Slide 5
     D.    Organizing evidence – use a consistent organization scheme. Database
           should include: Slide 6
           1.      Dates of documents
           2.      Sources of documents
           3.      Dates documents were obtained
           4.      Brief description of document contents
           5.      Subjects of documents
           6.      An identifying or Bates number (used by attorneys to keep track of
     E.    Coordination of evidence- Use link analysis (links between people, places
           and events) allows a large number of investigators to quickly understand
           complex scenarios and volumes of information. Analyst’s Notebook and
           Xanalys Watson.
     F.    Original documents vs. photocopies – use original in court, if possible.
           Only 4 situations (see page 234) permit the introduction of
           photocopies.Slide 7
     G.    Obtaining documentary evidence – auditors conduct seven types of tests
           (p. 234) which provide evidence – Slide 8
II.    Discovery sampling
       A.    Nature – a statistical sampling approach which deals with the probability
             of discovering at least one error in a given sample size, if the population
             error rate is a certain percentage – Slide 9. Used when full-population
             analysis using a computer is not possible.
             1. A type of attribute sampling and is based on normal probability
             2. Also referred to as stop & go sampling
             3. Allows auditor to quantify risks – See Table 8.2
       B.    Limitations – or the risk that existing fraud will not be discovered - sample
             may not be representative of population (sampling risk) or the possibility
             that auditor will examine a fraudulent check and not recognize it
             (nonsampling risk).
       D.    Sample size – The more confidence (99% vs. 90%) the auditor wants to be
             or the less risk the auditor wants to assume, the larger the sample size
             must be.
       E.    Documentation – must document the method used to determine sample
             size (specified population error rate, confidence level, method used to
             select sample, etc.)

III.   Hard to obtain documents –(Slide 10) bank records, tax returns and brokerage
       A. By subpoena – ordered by court or a grand jury to produce records. Only
           agents (law enforcement) of court or grand jury can obtain documents by
       B. By search warrant – Judge has been presented with probable cause that
           documents have been used in committing a crime. Warrants are executed only
           by law enforcement officials. Generally used in criminal cases.
       C. Voluntary consent – oral or written

IV.    Document experts – determines whether documents are authentic or not
       A.   Common questions about disputed documents – Table 8.3, p. 241
       B.   Warning signs a document may have been altered. pp. 240-241.
       C.   Organizations of document experts – FBI Laboratory Division and the
            American Board of Forensic Document Examiners, Inc.
       D.   Use a Qualified Document Examiner as opposed to a graphologist. See
            warning signs as to when a document should be submitted for examination
             Chapter 9: Conversion Investigation Methods
I.     Conversion – Used to determine how perpetrators convert and spend their stolen
       funds. Involves search of public records and other sources to trace purchases of
       assets, payment of liabilities, and changes in lifestyle and net worth

II.    Reasons for performing conversion searches –Slide 4
       A. To determine the extent of embezzlement.
       B. To gather evidence that can be used in interrogations to obtain a confession.

III.   Fraud examiners need to understand –Slide 5
       A. Federal, state and local agencies and other organizations that maintain
          information that can be accessed.
       B. Private and Internet based sources of information
       C. The net worth method of analyzing spending information – very helpful in
          determining probable amounts of embezzled funds.

IV.    Review Federal Sources – generally not as useful as state and local records in
       fraud investigations. Can be time consuming and costly
       A. Dept. of Defense -military records
       B. Dept. of Justice – FBI, DEA, U.S. Attorneys, etc
       C. IRS
       D. Secret Service
       E. Postal Service
       F. Central Intelligence Agency (CIA)
       G. Social Security Administration
       H. Bureau of Prisons

V.     Review State Sources
       A. State Attorney General
       B. Secretary of State
       C. Department of Business Regulation
       D. Bureau of Prisons

VI.    Review County and Local Records
       A. County clerk
       B. County land office or recorder of deeds
       C. Local Courts

VII.   Private Sources and Online Databases – Slide 7
       A. Trash investigation
       B. Utility records
       C. Credit reports
       D. Financial institution records
      E. Major credit reporting agencies
          1. Experian
          2. Equifax
          3. TransUnion
      F. Databases
      G. Internet Search

IX.   Net Worth Method - Slides 9 &10
       A.     Purpose
       B.     Calculations, p. 259

X.    Websites providing information on how to investigate and conduct searches:
      A.    How to Investigate –
      B.    Public records information sources-
      C.    Investigative Resources International –
      D.    Legal Resource Center:
            Chapter 10: Inquiry Methods and Fraud Reports

I.     Honesty testing - Slide 9
       A.    Pencil and paper test
       B.    Graphology
       C.    Voice stress analysis and polygraphs

II.    Interviewing - Overview
       A.      Most common technique used to investigate and resolve fraud.
       B.      Used to obtain:
               1. information that establishes the essential elements of the crime,
               2. leads for developing cases,
               3. the cooperation of victims and witnesses, and
               4. information on personal background and motives of witnesses.
       C.      Three types:
               1. Friendly- must determine motive
               2. Neutral – nothing to gain or lose from interview. Most objective and
                  helpful of interviewees.
               3. Hostile – most difficult to interview. Generally should be questioned
                  without prior notice.

III.   Characteristics of a good interview

IV.    Characteristics of a good interviewer
       A.     People persons and interact well with others
       B.     Others are willing to share information
       C.     Focuses on pertinent information
       D.     Display interest in the subject and in what is being said
       E.     Phrase questions in a nonaccusatory manner
       F.     Must not appear to be a threat and able to put interviewee at ease

V.     Reaction to Crisis
       A.     Denial
       B.     Anger
       C.     Rationalization
       D.     Depression
       E.     Acceptance
VI.     Types of Questions – Use A, B, and C if you only seeking information.
        A.     Introductory – used to start the interview and to get the interviewee to
        B.     Informational – Used to gather facts. May use open, closed and leading
               type questions.
               1. Open – calls for a monologue response and should be used most
                          during informational phase of interview.
               2. Closed – Require a precise answer – yes or no.
               3. Leading – Questions contain the answer as part of the question
        C.     Closing – used to reconfirm facts, obtain undiscovered information, seek
               new evidence and maintain goodwill.
        D.     Assessment – If you believe respondent is being deceptive, you may ask
               certain types of hypothetical, nonaccusatory questions. Used to decide
               whether to pose admission-seeking questions.
        E.     Admission-seeking - Slides 7 & 8 Used to clear an innocent person or to
               encourage a guilty person to confess. A reasonable probability exists that
               the interviewee has committed the act in question. Two purposes of
               admission seeking questions:
               1. Distinguish innocent persons from guilty ones
               2. Obtain a valid confession

VII.    Verbal and non-verbal clues of deception. Slides 5 & 6

VIII.   The Fraud Report – See Appendix B – Slide 10
        A. Includes findings, conclusions, recommendations, and corrective actions
           taken. Indicates pertinent facts uncovered relative to who, what, where, when
           how, and why regarding the fraud. Includes recommendations for control
        B. Should not include recommendations for disciplinary or legal action. General
           tone is neither accusatory nor conclusive as to guilt.

XI.     Important terms to review
          A.    Catharsis – p. 278
          B.    Proxemic – p. 286
          C.     Kinetics - p. 287
          D.    Chronemic – p. 286
          E.    Paralinguistic – p. 287
          F.    Norming or Calibrating – p. 290
          G.    Transitional statement – p. 283
          H.    Graphology – p. 306
                  Chapter 11: Financial Statement Fraud
I.     Nature of financial statement fraud-intentional misstatement of financial
       statements resulting from manipulating, falsifying, altering accounting records, or
       omission of amounts or disclosures. Generally involves collusion among top
       management personnel. Slide 4
       A.     Perceived financial pressures – company financial losses, failure to meet
              wall street’s earnings expectations, or the inability to compete with other
       B.     Perceived opportunity – weak board of directors, inadequate internal
              controls or the ability to override controls, or the ability to hide fraud
              behind complex transactions or related party transactions.
       C.     Rationalization-need to keep stock prices high, all companies use
              aggressive accounting practices, the problem is temporary, etc. Slide 10

II.    Elements of the Perfect Fraud Storm – Slide 5

III.   Financial Statement Fraud – Slide 6

IV.    Financial statement fraud statistics
       A.     Report of the National Commission on Fraudulent Financial Reporting
              (Treadway Commission)- Studied frauds for 10 year period, 1976-1987.
              Also examined 119 SEC enforcement actions (1981-1986)
       B.     COSO studied frauds occurring between 1987 and 1997. Approximately
              300 frauds were the subject of SEC enforcement releases. See pp. 368-369
              for characteristics. Found that most companies committing financial
              statement fraud were relative small, had inactive audit committees, had
              board of directors dominated by insiders and grey directors (significant
              equity ownership and little experience serving as directors), and family
              relationships among directors or officers) Slides 8 & 9
       C.     Sarbanes-Oxley Act directed the SEC to study enforcements actions filed
              from July 31, 1997 to July 30, 2002.
              1. SEC filed 515 enforcement actions financial reporting and disclosure
                 violations involving 164 entities.
              2. Greatest number of actions were in the area of improper revenue
                 recognition (fraudulent reporting fictitious sales, improper timing of
                 revenue recognition, and improper valuation of revenue).
              3. Second highest involved improper expense recognition (improper
                 capitalization or deferral of expenses, improper use of reserves, and
                 understatement of expenses).
              4. CEOs, president, and CFOs were members of management most often
       D.     2006 Report to the Nation
              1. 10.6 % (10.3% for 2008) of all cases involved fraudulent statements
                  with a median loss of $2,000,000 (same for 2008).
              2. Financial statement fraud schemes and the percentage of fraudulent
                 statement cases
                 a. Concealed liabilities – 45%
                 b. Fictitious revenues – 43.3%
                 c. Improper asset valuations – 40%
                 d. Improper disclosure – 37.5%
                 e. Timing differences – 28.3%

III.   Detecting financial statement fraud – Must understand the fraud exposure
       rectangle-Slide 10
       A.     Management and directors
              1. Must be investigated to determine their exposure to and motivation for
                 committing fraud.
              2.What is management’s ability to influence decisions for the
              3.An active Board of Directors or audit committee can do much to deter
              management fraud.
              4. Must understand their backgrounds, what motivates them and their
              degree of influence.
       B.     Relationship with others
              1. Fraud is often perpetrated with the help of real or fictitious
                 organizations (Enron-special purpose entities).
              2. Related parties often allow for other than arm’s length transactions.
              3. Unrealistic transactions with related organizations and
                 individuals is one of the easiest ways to perpetrate fraud.
              4. Examine relationships between the company and its auditors and
              5. Look at relationships between the company and investors.
              6. Examine relationships between the company and regulators
       C.     Organization and industry- Look out for
              1. Complex organizational structures that have no apparent
                 business purpose.
              2. Organizations without an internal audit department
              3. A board of directors or audit committee without outside directors
              4. Organizations that have off-shore affiliates with no apparent business
              5. An organization that has numerous acquisitions and recognized large
              merger-related charges.
      6.Family relationships who hold significant power or incompatible job
      7. Some industries are much more risky than others.
D.    Financial results and operating characteristics
      1. Kinds of exposures differ from fraud scheme to fraud scheme
      2. Examine large changes in account balances from period to period
      3. Understand what footnotes are really saying.
      4. Compare balances and amounts to similar organizations in the same
E.    Must know the nature of the client’s business, the kinds of accounts that
      should be included, the kinds of fraud that could occur in the organization
      and the kinds of symptoms those frauds would generate.

Appendix – Chapter 11: Recent Laws and Corporate Governance

I.    Largest US bankruptcies caused by financial statement fraud
      A.     WorldCom
      B.     Enron
      C.     Global Crossing
      D.     Adelphia

II.   Sarbanes-Oxley, 2002-Purpose of the Act?
      A.     Title 1 - PCAOB
             1.       Duties of the Board
             2.       Major provisions
                      a. Work paper retention by auditors
                      b. Second partner review
                      c. Report on internal control effectiveness by auditor
                      d. Inspection of audit firms
      B.     Title II - Auditor Independence
             1.       Specific nonaudit services prohibited (9)
             2.       Partner rotation required
      C.     Title III - Corporate Responsibility
             1.       Audit committees-characteristics and responsibilities
             2.       CEO and CFO responsibilities
      D.     Title IV – Enhanced financial disclosures
             1.       Material correcting adjustments
             2.       Off-balance sheet transactions
             3.       Internal control report by management
             4.       Code of ethics for senior financial officers
      E.     Title VIII- Corporate and Criminal Fraud Accountability
             1.       Criminal penalties (10 years in prison) for knowingly
                      destroying, altering, concealing, or falsifying records and
                      the failure of auditor to maintain for a five year period all
                      audit or review work papers.
              2.     Fine or imprisonment (up to 25 years) any person who
                     knowingly defrauds shareholders of public traded
       F.     Title IX – White-Collar Crime Penalty Enhancements-Corporate
              executives and directors:
              1.     Increased penalties for mail and wire fraud from 5 to 20
                     years in prison.
              2.     Failure to certify financial reports – maximum
                     imprisonment of 10 years.
III.   Stock Exchanges
       A.     NASDAQ
              1.     Requires majority of Board of Directors to be independent
                     and provides conditions where directors are not
              2.     Audit committee requirements
              3.     Code of ethics for directors, officers and employees
              4.     Going-concern audit qualification
       B.     NYSE
              1.     Requires majority of Board of Directors to be independent
              2.     Disclosure of corporate governance guidelines regarding
                     directors on company’s website
              3.     Written charter for audit committee
              4.     Must have internal audit function
              5.     Code of ethics for directors, officers and employees
                     disclosed on company website.

IV.    Will recent legislation prevent future frauds? Explain!
Chapter 12: Revenue-and Inventory-Related Financial Statement

I.     Common ways to Commit Revenue Fraud- ZZZZ Best, Qwest, Health
       South, Crazy Eddie, etc.
       A.     Fictitious Revenue – COSO study found this to be the most
              common way to manipulate revenue accounts. 43 % of the
              financial statement fraud cases, reported by the 2006 ACFE Report
              to the Nation, involved fictitious revenues. Related parties, sham
              sales, bill-and-hold sales, sales with condition or side letters,
              consignment sales, etc.
       B.     Recognize revenue early – Improper cut-off, holding books open
              after end of year.
       C.     Overstate real revenues – improper valuation of revenues, alter
              contracts, etc.
       D.     Understate allowance for doubtful accounts
       E.     Failure to record return goods or record after year end.
       F.     Not record discounts given to customers

II.    Revenue related fraud symptoms-Slide 7
       A.      Analytical symptoms – relate to accounts or relationships being too
       high or too low or exhibiting unusual characteristics.
       B.      Accounting symptoms- discrepancies in the records, missing
       documents, ledgers that don’t balance, etc.
       C.      Control symptoms- Override or lack of controls
       D.      Behavior or verbal symptoms- Individuals who commit fraud
       generally feel guilty which creates stress. Behavior changes to cope with
       stress or to hide symptoms.
       E.      Lifestyle symptoms- Not a factor in financial statement fraud in
       large companies.
       F.      Tips and complaints- Most frequent way of detecting fraud.

III.   Inventory and cost of goods sold fraud – Phar-Mor, Rite Aid, etc.
       A.     Types of transactions subject to inventory fraud, p 418.
       B.     Most common inventory related fraud schemes – Slide 9
              1.     Double counting
              2.     Capitalizing
              3.     Cutoff problems
              4.     Overestimating inventory
              5.     Bill-and-hold sales
              6.     Consigned inventory
C.   Symptoms
     1.    Analytical symptoms
     2.    Accounting symptoms
     3.    Control symptoms
     4.    Behavior or verbal symptoms
     5.    Lifestyle symptoms
     6.    Tips and complaints
Appendix: Financial Statement Fraud Standards, pp.643-650

I.     History of external auditor’s responsibility to detect fraud
       A.     Up to 1930’s detection of fraud was a major objective of the
              external audit examination.
       B.     From the late 1930’s until the issuance of SAS 53 in the 1980’s the
              importance of fraud detection was de-emphasized.
              1. Late 30’s- Statement on Auditing Procedures (SAP) No. 1-
              Auditors should have only a limited role in detecting fraud.
              2. 1960 – SAP No. 30- Examination cannot be relied upon to
              disclose defalcations and other similar irregularities.
              3. 1977 – Statement on Auditing Standards (SAS) No. 16 –
              Auditor has responsibility with inherent limitations of audit
              process to plan examination to search for material errors and
       C.     1988 – SAS No. 53- Requires auditor to provide reasonable
              assurance that material errors or irregularities would be detected.
       D.     1997 – SAS No. 82 – Clarified auditor’s fraud detection
              responsibilities and explicitly identified what auditors must do to
              try to discover fraud. See characteristics on page 647. First major
              statement on fraud-related auditing standards.
       E.     2002 – SAS No. 99 – Established additional standards to SAS 82
              and provides guidance for meeting responsibilities for auditors
              regarding the detection of fraud. See characteristics on pp. 647-

II.    Oct 1987- Treadway Commission (National commission on Fraudulent
       Financial Reporting) issued major report consisting of 49
       recommendations regarding roles of management, board of directors,
       independent auditor, and SEC concerning fraud responsibilities. The
       report also identified causal factors that can lead to financial statement

III.   Public Oversight Board (POB) – 1993 Special Report – provided
       recommendations for improving independent audits by enhancing its
       capacity and willingness to detect fraud. Also called for improved
       guidance beyond SAS 53 to assist auditors in assessing the likelihood of
       fraud. Lead to SAS 82.
IV.   Panel on Audit Effectiveness – Appointed by the Public Oversight Board
      in 1998 (at the request of the SEC) to examine the current audit model. A
      report was issued in August of 2000 that auditing standards should create a
      “forensic-type” fieldwork phase on all audits. Two objectives:
      A.      To enhance the likelihood that auditors will be able to detect
              material fraud.
      B.      To establish implicitly a deterrent to fraud.
Chapter 13: Liability, Asset & Inadequate Disclosure Frauds

I.     Understating liabilities – very difficult to detect – Slide 5
       A.     Improper use of reserves-example, Cookie jar reserves
       B.     Fraud Schemes – 19 different ways to understate liabilities, p. 450
       C.     Understate accounts payable – not recording purchases or
               recording after year end.
       D.     Understating accrued liabilities
       E.     Understating unearned revenues as earned revenues

II.    Factors that make frauds difficult to detect by auditors – p. 449

III.   Detecting unrecorded liabilities – Slide 6
       A.     Analytical symptoms
              1.     Accounts payable – understatements usually relate to
                     reported balances that appear too low.
              2.     Notes and mortgage payable – unreasonable relationships
                     between interest expense and recorded liabilities.
              3.     Contingent liabilities- analytical symptoms not particularly
       B.     Accounting or documentary symptoms
              1.     Invoices received but no liability recorded.
              2.     Large purchases recorded at beginning of period.
              3.     Presence of receiving reports with no recorded liability.
              4.     Errors in cut-off tests.
              5.     Documentary symptoms related to all kinds of
                     understatements, p. 454

IV.    Searching for symptoms
       A.     Change in recorded balances – period to period
       B.     Focus on change in relationships from period to period - common
              size statements and vertical analysis.
       C.     Comparing financial statement information with that of other
       D.     Ratios used in detecting liability frauds, p. 457

V.     Overstatement of Asset Fraud – Slide 7
       A.     Improper capitalization of Costs as assets
       B.     Inflated assets through mergers and acquisitions
       C.     Overstatement of fixed assets
       D.     Cash and short-term investment fraud
       E.     Overstatement of accounts receivable or inventory
     VI.    Inadequate disclosure fraud
            A.     Three groups – Overall misrepresentations, misrepresentations in
                   the management discussion and analysis (MD&A),
                   misrepresentations in footnotes to the financial statements.
            B.     Techniques used to detect inadequate disclosures

                   Chapter 14: Fraud Against Organizations

I.   General statistics – Theft by employees – 2006 & 2008 Report to the Nation-
                                     Percent               Median Loss
     A.     Gender                   2006 2008             2006      2008
            1.       Male            61      59            $250,000 $250,000
            2.       Female          39      41            $102,000 $110,000
     B.     Age
            1.       Over 60         2.8     3.9           $713,000 $435,000
            2.       51-60           15.3 18.9             $350,000 $500,000
            3.       41-50           35.0 35.5             $250,000 $250,000
            4.       36-40           16.0 16.2             $135,000 $145,000
            5.       31-35           16.0 12.8             $134,000 $113,000
     C.     Education
            1.       Postgraduate 12.2 10.9                $425,000 $550,000
            2.       Bachelor        33.4 34.4             $200,000 $210,000
            3.       Some College 21.6 20.8                $200,000 $196,000
            4.       High School 32.8 33.9                 $100,000 $100,000
     D.     Occupational Fraud
            1.       Asset Misappr.91.5 88.7               $150,000 $150,000
            2.       Corruption      30.8 27.4             $538,000 $375,000
            3.       F/S Fraud       10.6 10.3             $2,000,000 $2,000,000
     E.     Asset Misappr.
            1.       Cash            87.7                  $150,000
            2.       Non-cash        23.4                  $200,000
            3.       Skimming        18.9                  $76,000
            4.       Larceny         14.2                  $73,000
     F.     Corruption               % of corruption cases
            1.       Bribery         42.7
            2.       Conflict of Int 61.6
            3.       Extortion       16.9
            4.       Ilegal Grat. 29.8
     G.     Other – All cases
            1.       Median loss $159,000                  $175,000
            2.       Loss of revenues 5%                          7%
            3.       Duration – Months 18                         24
            4.       Detection-Method
                     Tip                  44%                     46%
II.    Asset Misappropriations – Theft or misuse of assets
       A.     Three opportunities to steal –Slide 5
              1.     Cash or other assets as they come into organization
              2.     Cash, inventory and other assets on hand
              3.     Disbursement fraud – having org. pay for something it should not
                     pay or pay too much.
       B.     Cash
              1.     Larceny-theft of cash after it has been recorded
              2.     Skimming- theft of cash prior to recording
       C.     Fraudulent disbursements
              1.     Check tampering
              2.     Register disbursement schemes
                     a. False refunds
                     b. False voids
              3.     Billing schemes
              4.     Expense schemes
                     a. Mischaracterizing expenses
                     b. Overstating expenses
                     c. Submitting fictitious expenses
                     d. Submitting same expenses multiple times
              5.     Payroll schemes
                     a. Ghost employees
                     b. Falsified hours and salary
                     c. Commission schemes
                     d. False workers’ compensation claims
       D.     Theft of inventory and other assets
              1.     Misuse of assets
              2.     Assets stolen

III.   Corruption – Slides 8 & 9
       A.     Bribery
              1.      Kickbacks
              2.      Bid-rigging
       B.     Conflicts of interest
              1.      Purchase schemes
              2.      Sales schemes
       C.     Economic extortion schemes
       D.     Illegal gratuity schemes
                               Chapter 15: Consumer Fraud

I.     Nature – Any fraud against an individual- Examples – telephone fraud, magazine
       fraud, sweepstakes fraud, foreign money offers, internet services, internet
       auctions, identity theft, and marketing schemes.

II.    Federal Trade Commission Survey
       A.     Nearly 25 mission adults or 11.2% percent of the adult population were
              victims of fraud. Racial and ethic minorities were much more likely to be
              victims of fraud.
       B.     Consumers with high levels of debt were more likely to be victims of
       C.     Most frequent reported frauds
              1.     Advance-fee loan scams
              2.     Buyers’ club memberships or bills for unordered publications
              3.     Credit card insurance scams and credit repair

III.   Identity Theft – the largest type of consumer fraud
       A.      Approximately 40% of frauds reported to FTC involved some          form
               of identity theft.
       B.      Uses another person’s name or other identifying information to commit
               fraud or other crimes.
       C.      Those whom we trust are in the best position to defraud us-neighbors,
               dinner servers, baby sitters, etc.
       D.      The identity theft cycle. Slide 7
               1.      Discovery
               2.      Action
               3.      Trial
       E.      Ways of stealing identity
       F.      Proactive ways to protect yourself against identity theft- Slide 8
               1.      Guard your mail from theft
               2.      Opt out of preapproved credit cards
               3.      Check your personal credit information at least annually
               4.      Guard social security card and number
               5.      Safeguard all personal information
               6.      Guard trash from theft
               7.      Protect wallet and other valuables
               8.      Protect the home, computer, passwords.
       G.      After identity theft occurs – FTC is the primary agency responsible for
               helping victims of identity theft

IV.    Foreign Advance-fee scams
       A.     Nigerian money offers
       B.     Clearinghouse scam
       C.     Purchase of real estate scam
       D.     Disbursement of money from wills
V.      Work at home schemes
        A.    Multilevel marketing
        B.    Front loading

VI.     Telemarketing fraud
        A.    Involves large and small transactions
              1.      Large transactions- investment scams
              2.      Small transactions-sweepstakes, bogus          fees,   or   magazine
        B.    Telephone is a major tool in this type of scam
        C.    Safeguards against telemarketing fraud

VII.    Scams prey on the elderly- Why?
        A.      Elderly are often lonely and fraudsters use loneliness to build a
        relationship of trust.
        B.      If they are conned out of money they rarely tell family and friends or even
        report the incident.
        C.      Elderly are extremely trusting
        D.      Elderly often have traits of greed, fear, excitement and gullibility

VIII.   Investment Scams – Perpetrators usually make fraudulent promises or
        misstatements of fact to induce people to make investments. Symptoms: (Slide
        A.     Unreasonable promised rates of return
        B.     Investments that do not make sound business sense.
        C.     Pressure to get in early on the investment
        D.     Use of a special tax loophole or a tax avoidance scheme
        E.     A business with a history of bankruptcy or scandals
               Chapter 16: Bankruptcy, Divorce, and Tax Fraud

I.   Tax Fraud
     A.     Definition – intentional underpayment of taxes – includes not reporting
            income, deliberately overstating tax deductions and exemptions.
     B.     Penalties - line between negligence and fraud is not always clear.
            1.      Mistakes – 20% penalty
            2.      Fraud – 75% penalty
     C.     Audit of return
            1.      May assess civil fines and penalties or
            2.      Refer your case to IRS Criminal Investigation (CI) Division (arm
            of IRS that investigates tax fraud).
     D.     Criminal Investigation Division – Tax and money laundering crimes
            1.      Combines accounting and law enforcement skills.
            2.      Trained to follow the flow of the money.
            3.      Trained to conduct complex financial investigations.
            4.      Conviction rate – 98%.
            5.      Individual taxpayers commit 75% of the tax frauds-mostly
                    middle income earners. Corporations make up most of the rest
            6.      Most common tax fraud – underreporting income. Committed
                    mostly by self-employed people who work in restaurants, clothing
                    store owners, car dealers, etc.
            7.      To be a special CI agent – must be a US citizen and not over 37
                    years old. Must have 15 hours of accounting.
     E.     Tax evasion –Willfully evading tax or willfully failing to pay a tax,
            making false statements on any return, or aiding in the preparation of
            fraudulent tax returns. The following sentence and penalties can be
            assessed (in addition to interest and penalties on the interest from the due
            date of the return to the payment date): IRC section 7201
            1.      Imprisonment up to five years.
            2.      Fine of up to $250,000.
            3.      Civil fraud penalty of 75% on the portion of the underpayment due
                    to fraud.
            4.      Costs of prosecution
     F.     Statute of limitations
            1.      IRC section 6531-generally a person cannot be tried or punished
                    unless indicted within three years of the offense.
            2.      The willful attempt to evade taxes extends the statute of limitations
                    to six years. The six year period begins from the last tax evasion
                    act and could be as later than the due date of the tax return.
II.   Divorce Fraud
      A.     General
             1.     Divorce fraud – intimidation, concealment, deceit, or breach of
                    spousal duties.
             2.     More than 1 million divorce cases are filed annually.
             3.     Approximately 50% of all marriages fail
             4.     Divorces generally result in hostility between the spouses
             5.     People involved in divorce cases are required to supply each other
                    and the court with complete financial statements.
      B.     Three Categories
             1.     Fraud causes the divorce
             2.     Divorce is used to perpetrate the fraud
             3.     Divorce is used to conceal the fraud
      C.     Most divorce litigation result from two factors
             1.     Plaintiff spouse alleges defendant hid assets from divorce court.
             2.     The values assigned to asset were unrealistically low-resulting in
                    unfair divorce settlement.
      D.     The most common area of fraud connected with divorce is asset
             concealment. Red flags that assets might be concealed:
             1.     Transfers of property or large payments to related parties or
                    individuals, such as relatives.
             2.     Frequent and unusual transfers between bank accounts, particularly
                    overseas and business and personal accounts.
             3.     Unusually large payments to particular persons that are not
             4.     Unusual or rapid reductions in assets.
             5.     Inconsistencies between tax returns and the official forms filed in
                    the divorce court.
             6.     Travel to off-shore tax havens or locations that allow secret bank
             7.     Missing, inaccurate, or damaged records.
III.   Bankruptcy Fraud
       A.     Majority of bankruptcies come in the form of complete liquidations
       B.     Most common schemes- concealment of a debtor’s assets (70% of
              bankruptcy fraud) and bust-outs. Petition mills and multiple filings next
       most frequent schemes. More than 10% of bankruptcy cases involve bankruptcy
       C.     Purposes of filing – Slide 5
              1.     Gives debtor relief from creditor collection and foreclosure
              2.     Protects creditor from unfair collection efforts by other creditors
              3.     Allows debtor to work out an orderly plan to settle debts or
                     liquidate assets and distribute the proceeds to creditors in a way
                     that treats creditors equitably.
       D.     Bankruptcy code
              1.     Title 11 – refer to as the bankruptcy code. Governs the bankruptcy
                     process and provides for several types of bankruptcy.
                     a. Chapters 1, 2 and 5 – general provisions that apply to all
                     b. Chapters 7 and 11 apply to corporations and individuals
                     c. Chapter 7 – complete liquidation, shutting down of the business.
                     Completely discharges debtor from all debt with no obligation to
                     make payment from future income.
                     d. Chapter 11 – Creditors are told to back-off and business is
                     allowed to operate in a reorganized fashion
                     e. Chapter 13 – reorganizations that can be used by individuals
                     whose income is too large to permit them to file under Chapter 7.
                     Debtors are required to make specific payments to creditors for a
                     specific number of years.
                     f. If Chapters 11 and 13 don’t work, judge can order a Chapter 7
              2.     Civil and Criminal bankruptcy fraud statutes
                     a. Criminal – Prosecuted by US Attorney’s office in applicable US
                     District court
                     b. Civil – Conducted in US Bankruptcy Court.
              3.     Bankruptcy fraud penalties- Maximum of 5 years in prison and
                     maximum fine of $250,000 or both per offense.
       E.      Concealment of Assets
              1.     Title 18, Section 152 – crime to knowingly and fraudulently
                     conceal property of a debtor’s estate or falsify any documents,
                     records or statements.
              2.     Means of concealing assets, page 581 – Slide 6
              3.     Red flags of concealment
      F.     Fraud Investigator’s Relationship
             1.     Allows trustees to employ, with approval of court, attorneys,
                    accountants, etc.
             2.     Allows a creditors’ committee to employ attorneys, accountants,
             3.     In order to be compensated from estate funds, must be employed
                    under Code Section 327 and approved by the bankruptcy judge.

IV.   Money Laundering
      A.    Nature – Process by which one conceals the existence, illegal source, or
            illegal application of income and then disguises that income to make it
            appear legitimate.
      B.    Who are the criminals?-drug traffickers, embezzlers, corrupt politicians
            and public officials, mobsters, terrorists, and con artists.
      C.    Money laundering process: See Figure 16.1 and Slide 10
            1.       Placement
            2.       Layering
            3.       Integration
      D.    Combating Money Laundering – Financial Action Task Force (FATF)
      E.    Red Flags of Money Laundering- Page 584.
                   Chapter 17:             Fraud in E-Commerce

I.     E-commerce opportunity elements that create increased risks –Slide 4
       A.      New technologies for which security developments often lag transaction
       B.      Complex information systems make installing controls difficult
       C.      Transfer of large amounts of information poses theft and identity risks
       D.      Removal of personal contact allowing for impersonation or falsifying
       E.      Lack of physical facilities that facilitates falsifying websites and business
       F.      Electronic transfer of funds allows large frauds to be committed more
       G.      Compromised privacy often resulting in use of stolen or falsified

II.    E-commerce risks inside of organization – Slide 6
       A.      Abuse of power granted to users-programmers and technical support
       personnel often have supervisor access to system they create and administer.
       B.      Data theft-personal information about customers can be sold or misused.
       C.      Passwords-left to end user and cannot be controlled (Social
       D.      Sniffing (viewing of information that passes along network line)- Used to
       gather information from unencrypted communications.
       E.      Laptops-may be used to bypass firewalls and controls. Employees walk
       laptops from unprotected networks to protected networks.
       F.      USB drives and portable external hard drives-can download significant
       amounts of information from internal networks.

III.   E-commerce risks outside of organization- Slide 7
       A.   Internet enables hackers to gain access to personal systems
            1.      Cross international boundaries and are mostly anonymous
            2.      Tracing and prosecution very difficult
            3.      If caught-sentences are light
       B.   Phishing-e-mail or pop-up messages asking for personal information.
            Example- Impersonates technical support for employees
       C.   False websites- Used to trick users to provide personal information.
       D.   Spoofing-hides identities by changing information in the header. Forges
            From: field
       E.   Falsified identity – pretending to be someone you’re not.
IV.     Preventing e-commerce fraud- security measures should be based on time-tested
        methods that are mathematically sound. Slide 8
        A.     Security through obscurity should never be an option.
        B.     Should use virtual provate networks, firewalls, public & private key
               infrastructure, SSL encryption, etc.

V.      Internal controls in e-business
        A.      Control environment
                1.     Integrity and ethical values
                2.     Participation by board of directors and audit committee
                3.     Management philosophy
                4.     Human resource policies and practices.
        B.      Risk assessment- identifies key risks for electronic exchange of
                information and money.
        C.      Control activities
                1.     Separation of duties
                2.     Proper authorization of transactions
                3.     Adequate documents and records
                4.     Physical control over asset and records
                5.     Independent checks on performance

VI.     Detecting fraud in e-business – Slides 9 & 10
        A.     Understand the business or operations of the organization
        B.     Identify what frauds can occur
        C.     Determine the symptom that frauds would generate
        D.     Use databases and information systems to search fro symptoms
        E.     Follow up on symptoms- what causes these symptoms.

VII.    Other Preventive Measurers
        A.     Regular audits of user behavior
        B.     Train employees on what e-commerce fraud looks like
        C.     Use employee tip lines

VIII.   Terms
        A.      Sniffing
        B.      Phishing
        C.      Internet worms
        D.      Wartrapping
        E.      Biometics
        F.      Trojan horse
        G.      Spoofing
        H.      Bust-outs
        I.      Encrypton
        J.      Social engineering
                     Chapter 18:            Legal Follow-up

I.    Court system
      A.    State courts – Slide 4
             1.     State and local courts generally handle fraud cases.
             2.     Lower-level trial courts- Initial actions are heard for
                    misdemeanors and pretrial issues for felony and civil
                    cases that are below $10,000. There is no jury trial in
                    probate, family law, estate issues and equitable issues.
             3.     Higher-level trial courts-Initial actions for felonies and
                    cases of more than $10,000.
             4.     Intermediate appellate or reviewing court- 3 judges per
             5.     Higher level Appellate-5 to 9 judges- final level

      B.     Federal courts – Slides 5 & 6
             1.     Frauds are tried in tax court (tax fraud), bankruptcy courts
                    (bankruptcy fraud), and US district courts (mail frauds, etc.)
             2.     Hear fraud cases that involve federal laws or include several states.
                    The controversy must exceed $50,000.
             3.     U.S. Court of Appeals-Hears appeal of judgments rendered in
                    district courts.
             4.     Supreme Court- Reviews decisions made by Courts of Appeals in
                    the 12 circuits.

II.   Criminal law
      A.    Prosecution either federally or by a state for violating a statute that
            prohibits activity.
      B.    May serve jail sentences, pay fines and make restitution to victims.
      C.    Must be proven guilty beyond a reasonable doubt.
      D.    Juries must rule unanimously on guilt.
      E.    Provides more protection for rights of the defendant than does civil law.
            1.      Fourth Amendment –Protects defendants against unreasonable
                    searches and seizures by the government.
            2.      Fifth Amendment- provides the right to refuse to incriminate
            3.      Sixth Amendment- relates only to trials.
      F.    The criminal litigation process – Slide 9
            1.      Filing criminal charges
            2.      Arresting and charging the defendant
            3.      Preliminary hearings
            4.      Arraignment
            5.      Discovery
            6.      Pretrial motions
            7.      Trial and appeal
       G.     Preliminary hearings vs. grand jury, pp 630-631
              1.     Preliminary hearing – Used to determine whether “probable
                     Cause” exists to charge defendant with a crime. Held before a
                     judge and hearsay and illegally obtained evidence can be heard.
                     Defendant is represented by an attorney who can cross-examine
                     prosecution’s witnesses.
              2.     Grand jury – Prosecution generally prefers to obtain a grand jury
                     indictment. Consist of 16-23 people. Can consider any evidence,
                     even that which would not be admissible at trial. Defendants do not
                     have a right to be notified that a grand jury is considering evidence
                     against them. Defendants are not allowed to review the evidence,
                     confront their accuser, or present evidence in their defense. They
                     cannot be accompanied by their attorneys. The Sixth Amendment
                     protections are denied during the grand jury process.

III.   Civil law
       A.      Provides remedies for violations of private rights
       B.      Purpose- to compensate for harm done to individual or organization.
       C.      May use a few as 6 jurors.
       D.      Verdict need not be unanimous.
       E.      Often heard by judges instead of juries.
       F.      Prove case by the “Preponderance of the evidence.”

IV.    Civil litigation process – four steps – Slide 8
       A.       Investigation and pleadings
       B.       Discovery
       C.       Motion practice and negotiation
       D.       Trial and appeal

V.     Litigation services provided by accountants
       A.      Consultant- Hired by an attorney to gather and interpret facts, prepare
               analyses, help interpret evidence, advise about issues and strategies
               involved in a legal matter, locate other accountants to act as consultants or
               expert witnesses, and help expert witnesses form their opinions. A
               consultant is immune from discovery.
       B.      Masters and special masters-appointed by the court to assist the court in
               some matter-determine certain facts or compute damages. Special master-
               appointed by the court to act as the court’s representative. Compensation
               is set by the court.
C.   Expert witness –retained by an attorney or court as an expert to testify in a
            judicial or administrative proceeding. – Slide 10
            1.      Can offer opinions based on experience, education, or training
            about the fraud. A fact or character witness cannot offer opinions but can
            only testify as to facts.
            2.      Fraud expert must qualify as expert witness (voir dire)
            3.      May testify about- nature of the fraud, the damages suffered in the
            fraud, the negligence of the victim in allowing the fraud to happen,
            standards (auditing or accounting) that were violated, etc.
            4.      Deposition of the expert
                    a.       What are the expert’s opinions?
                    b.       Determine the credentials and experience of the expert.
                    c.       Identify evidence that can be used to impeach the expert or
                             discredit testimony during the trial.
                    d.       Assess how difficult the expert will be in the case.
            5.      Do’s and Don’ts at deposition, trial, and cross-examination, Page
            6.      Accountants hired to testify as an expert may not use the attorney-
            client privilege. However, a non-testifying expert may fall under an
            attorney work product privilege.

D.   Written Agreement – Accountants asked to perform litigation services should
     enter into a written agreement with the employing attorney. Items covered by the
     written agreement should include:
             1.     Name of the attorney client
             2.     Litigants’ name and place of the legal proceeding
             3.     Nature of the litigation services to be performed
             4.     Whether accountant will be asked to testify as an expert witness
             5.     Restriction imposed on use and disclosure of practitioner’s work
             6.     Any conflicts of interest with the litigants or attorneys
             7.     Whether accountant will be protected by the attorney work product
             8.     Circumstances for termination
             9.     Fee

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